Rho measures the sensitivity of an option's price to changes in interest rates. It is defined as the increase in the price of an option or options portfolio resulting from a 1% increase in interest rates.
Relevance of Rho
Rho is often overlooked by options traders because interest rates are unlikely to change significantly during the lifespan of most options spreads. Therefore, changes in interest rates are usually ignored.
However, there are situations where Rho deserves more attention. Long-term options, such as LEAPS (Long-Term Equity Anticipation Securities), are more sensitive to changes in interest rates and thus have a higher Rho.
For example, at the time of writing, an at-the-money AAPL call option with 32 days until expiration has a Rho of 0.3. This means a 1% interest rate increase would result in a small 0.3% increase in the option's price. In contrast, a LEAP with 578 days until expiration has a Rho of 2.2. Therefore, any LEAP strategy, such as LEAP Covered Calls (Poor Man's Covered Call), would be more significantly affected by changes in interest rates.
Rho should also be considered when interest rates are expected to change. For instance, at the time of writing, there is a strong possibility that the Federal Reserve will end its quantitative easing (QE) program, which could lead to an increase in interest rates. Consequently, all things being equal, we might see an increase in options prices over the next few months or years.
Conclusion
In summary, Rho can be an important factor in specific circumstances, such as when interest rates are expected to change or when dealing with long-term options. However, in general, Rho is less critical compared to other Greeks like Delta, Gamma, Theta, and Vega.